A capital gains tax (CGT) planning scheme involving the use of Irish trusts has been defeated by HMRC in the First Tier Tax Tribunal (FTT). We examine the case and the views expressed by HMRC.
Between 1989 and 2002 Sir Fraser Morrison, who had made his fortune in the construction business, set up three trusts for the benefit of himself, his wife and their three adult children. The trusts owned substantial shareholdings in AWG PLC worth approximately £14.5 million. The trusts wished to diversify their assets but could not sell the AWG holding without a CGT liability in the region of £3-£4 million. Consequently, a plan was devised intended to take advantage of the much lower CGT bill that would arise if the shares were sold in Ireland. This involved :
- the creation of three Irish trusts on mirror terms to the three Scottish trusts
- the grant by the Irish trustees to the Scottish trustees of put options for the sale of the AWG shares
- the exercise of the options followed by the Irish trusts’ disposal of the AWG shares and
- the export of the Irish trusts to Scotland by the end of the same tax year.
If this plan was successfully implemented the CGT payable on the sale of the AWG shares would then be considerably less than the CGT otherwise payable.
The relevant tax law at the time
The tax law that enabled this plan to apparently work was comprised in s 144ZA of the Taxation of Chargeable Gains Act 1992 (TCGA) which provided that when the option was exercised the CGT on the disposal was calculated on the actual consideration paid, rather than substituting market value (which would otherwise be the case on a transaction between connected persons). Thus setting the option price at the Scottish trustees’ acquisition cost plus indexation meant that the option could be exercised without any CGT being payable by the Scottish trustees.
Anti-avoidance legislation contained in ss 86 and 87 TCGA which provides that gains made by an offshore trust with non-UK resident trustees can be brought into charge to CGT on the settlor or the beneficiaries, was avoided by ensuring that the Irish trusts became UK resident by the end of the tax year when the disposal took place. This meant that ss 86 and 87 were then inapplicable as the trust was UK resident during part of the tax year.
The scheme was duly notified to HMRC under the DOTAS regulations and put into effect resulting in a CGT bill of £53,638.82 as opposed to £3-£4 million.
The FTT hearing
The FTT used the principle established in the case of Ramsay V HMRC, and followed in a number of subsequent cases, to attack the tax planning carried out by the trusts. The principle established in Ramsay is that where there is a pre-ordained series of transactions in which steps are inserted that serve no commercial purpose other than to avoid tax, for tax purposes those steps can be ignored and the end result of the series of transactions taxed accordingly. If therefore the FTT found that the only point of the creation of the Irish trusts and the exercise of the put options was to avoid tax then they could ignore these steps and treat the disposal of the AWG shares as being made by the Scottish trustees and liable to substantial CGT. The taxpayers argued that Ramsay should not apply as it was not a single composite transaction and the sale of the AWG shares was not pre-ordained. HMRC argued that a series of transactions should be treated as a single composite transaction “where there is an expectation that the series is to be carried out.”
The FTT reiterated that a purposive approach must be taken to the interpretation of tax legislation and that the purpose of the CGT legislation is clear: to tax gains with a commercial reality on the disposal of assets. They went on to say, “It is not a question of respecting each individual step and concluding that, as they are formally and individually immune from challenge, no fiscal liability can attach. Rather it is a question of looking at the reality of the facts and the purposes of the relevant statutory provisions.” The creation of the Irish trusts and the exercise of the put options (at considerably less than market value) had no commercial, business or trust related family purpose apart from the avoidance of liability to tax. The scheme was “expected, planned and likely to be carried into effect”, the Ramsay principle applied and the FTT decided that CGT would be charged accordingly.
The FTT commented that the arrangements in this case “might be regarded as abusive in another context”. The circumstances of this case arose before enactment of the General anti-abuse rule (GAAR) but if they were to occur today possibly HMRC may have tried to rely on GAAR to defeat the scheme as well as invoking Ramsay. In considering whether an arrangement is abusive under GAAR regard will be had to whether the means of achieving a tax advantage involves one or more contrived or abnormal steps. As HMRC regards the disposal of assets which has no purpose other than to achieve a desired result, and the involvement of third parties other than to secure a desired result, as being contrived or abnormal steps it would appear that some of the necessary elements to fall within GAAR were satisfied.
All in all, there must be considerable doubt in the current climate about the viability in the future of “clever” tax planning schemes involving multiple steps, some of which have no apparent purpose.
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